A main takeaway of the 115-page report released Tuesday is that FHFA plans to issue a proposed rule that would clarify the mission of the Federal Home Loan Bank System while providing metrics and thresholds for measuring how each of the 11 FHLBs advance that mission. FHFA also is considering how to incorporate what it calls "mission achievement" in its exam processes, and may potentially include a stand-alone "mission examination" rating for each of the banks.

But one key concern about such a proposal is whether the Home Loan Banks will embrace the FHFA's suggestions, given that the Home Loan Banks have been championing their role of providing liquidity and thus financial stability to member institutions, and the possibility that many of the proposed changes would cut into profits that members receive in the form of hefty dividends. 

"There are ways to make this work, but at the end of the day none of this will work if the FHLBs don't get engaged," said Peter Knight, the cofounder of Policy Kinetics, who worked for 19 years as a director of government relations at the Federal Home Loan Bank of Pittsburgh. 

Experts who have followed the FHLBs for decades called the report and its suggestions an ambitious undertaking. The FHFA's recommendations are the beginning of a multi-year effort to encourage the government-sponsored enterprise to do more to promote liquidity alongside housing and community development. Most of the changes will be implemented through ongoing supervision, guidance and rules. But some of the more sweeping changes — such as increasing the amount of liquidity steered toward affordable housing and oversight of executive compensation — would require Congressional action.

Former FHFA Director Mark Calabria, a senior advisor at the Cato Institute, said the report's findings and recommendations were in line with what he expected, and were reasonable given the lack of specificity in the Federal Home Loan Bank Act of 1932 about membership eligibility and other key provisions.

Calabria said the FHFA was justified in seeking congressional input on whether there should be a renewed focus on housing finance, one that could put stricter limits on the types of institutions that can access FHLB advances or the types of activities they can engage in. But he urged his former agency not to wait for Congress to take action, noting that some changes are already well within its reach. 

"It would be great if Congress would come in and clarify some of these things, and FHFA is not without justification in asking if there should be a refocus of purpose," Calabria said. "But there are aspects, like limiting the exposure of any one member, that FHFA can do on its own."

Michael Ericson, president and CEO the FHLB Chicago, said in an interview that "a tremendous amount" of borrowing by members goes toward supporting housing and community development. As an example, he cited a program in Chicago that provides interest-free advances to member institutions that make direct small business loans that support community development. He said the FHLBs are not doing enough to promote their work. 

"This report doesn't change anything that we do today. We're doing activities in our members' districts to support economic development, to support small businesses, to support housing. These are all things that we're doing today," Ericson said. "I think what gets missed in a lot of this is, historically, we have not highlighted all of the great things that we've been doing. But this process has educated us that we need to do a much better job of informing others about the great things that we are doing. And I think that's been missed in some of the narratives."

Ericson pushed back against the FHFA's plans to propose a rule that would require that certain members hold at least 10% of their assets in residential mortgage loans on an ongoing basis to remain eligible for FHLB financing. FHFA said in the report that it expects to analyze the impacts of a 10% asset requirement on different member institutions, such as insurance companies and community development financial institutions, as part of the rulemaking process. 

"There are certain things in the report that we wouldn't agree with and this is an area that we would object to," Ericson said.

He noted that in 2014, the FHFA proposed a similar rule that the FHLBs also objected to. 

"This isn't really new ground that the finance agency is potentially charting here," he said. "There are a number of factors in place that impact a member institutions' assets they have on their balance sheet. One day, they could easily pass the test and the next day, they may not be able to. If you are a stable, reliable partner to your member institutions, they need to know that and they need to know what the rules are. And introducing volatility like that would be very difficult to manage, so it's not something that we would agree to."

The review of the Home Loan Bank began in July 2022, well before the March 2023 liquidity crisis led to increased scrutiny of FHLBs after it was discovered that they lent billions to three banks that later failed — Silicon Valley Bank, Signature Bank and First Republic Bank — and to another, crypto-friendly Silvergate Bank, which self-liquidated. Those banks all received short-term loans, known as advances, in an attempt to make up for massive declines in deposits. In the first week of March 2023 alone the FHLBs funded $675.6 billion in advances — the largest one-week volume in the history of the government-sponsored enterprise.

Calabria said it was predictable that the FHFA report would focus on the role federal regulators play in monitoring the health of member banks, given the string of large bank failures this spring. But he argued that the FHLBs already rely too heavily on the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency to assess the creditworthiness of banks. He urged the FHLBs to take a more discerning approach to issuing advances moving forward.

"The Federal Home Loan Banks need to take a separate view of their members than their primary regulators. They can share information but they shouldn't be overly deferential,"  Calabria said. "Supervising a bank and dealing with a counterparty are two different things with two different sets of goals. I worry that this report blurs that line."

The FHFA specified in the report that the FHLBs should not be used as a "lender of last resort," noting that banks should not be "overly reliant" on the FHLBs for liquidity. Moreover, banks should have the necessary agreements or collateral positions in place to borrow from the Federal Reserve's discount window, the report said.

"The reliance of some large, troubled members on the FHLBanks, rather than the Federal Reserve, for liquidity during periods of significant financial stress may be inconsistent with the relative responsibilities of the FHLBanks and the Federal Reserve," the FHFA report said.

 To that end, FHFA plans to address weaknesses in the FHLB's oversight of its members' liquidity and credit risk management, which Ericson said is already underway. 

"We will implement recommendations that the Finance Agency has provided to the Federal Home Loan Banks," Ericson said. "The banks have robust credit risk management practices in place today and they had credit risk management practices in place going into the crisis.  And we're implementing the guidance that the Finance Agency has provided to us." 

Cornelius Hurley, an advisor to the Coalition for FHLB Reform and a former independent director of the FHLB of Boston, said the debate about the FHLBs should focus on the subsidy that members receive through the implied government guarantee on the debt the system issues. 

"The Home Loan Banks and their members view the FHLB system as an entitlement to low-cost funds, and they are enriching themselves without providing something in return," Hurley said. 

The FHFA report estimated the value of the implicit guarantee at $4.7 billion in 2022. By comparison, the FHLBs collectively contributed roughly $200 million in affordable housing subsidies last year. The Bank Act requires that each FHLB contribute at least 10% of its prior year's net earnings on an annual basis to fund affordable housing programs.

Kathryn Judge, a law professor at Columbia University who has researched the FHLBs, said the report was a step in the right direction, but said that more needs to be done. She said the report identifies several key challenges in the current system, including the risks to the Federal Deposit Insurance Corp. and the National Credit Union Administration, which are responsible for paying off advances to the FHLBs ahead of other creditors when institutions fail. She applauded many of the changes outlined in the report, including those that would require the FHLBs to ensure members are financially healthy before making advances.

"In light of what transpired this spring, those bank regulators should be eager to work more closely with the Federal Home Loan Banks," she said. 

But Judge said the report fails to meaningfully address what she sees as the core issue of the FHLB system: its mission. As it stands now, the FHLBs extend loans to banks of all sizes for all types of uses, a reality that she said goes against the spirit of the system, which was conceived to support thrifts at a time when they could not access the Fed's discount window.

"The short-term goal should be to implement as many suggested rules as possible," Judge said. "Then there should be conversations about how to help the public enjoy the benefits from the public subsidies the system enjoys and how to harness the system to support small institutions and create credit access."